Different Incentives for AFA’s – GC’s vs. Managing Partners

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Recently Bruce MacEwan of Adam Smith, Esq. did a great post on his blog on the different incentives that General Counsels (GC’s) and Managing Partners have regarding Alternative Fee Agreements (AFA’s).  GC’s are accountable to their shareholders, while Managing Partners are accountable to their partners.  Bruce’s point was that GC’s are incented by their shareholders to reduce costs and push AFA’s, while managing partners are incented by their partners to run a profitable firm.  I’m paraphrasing a bit, but here’s the full post for your info.

So given the current difference in incentives for GC’s and Managing Partners, is there a way to reconcile the two points of view and come to some agreement for a mutual goal and appropriate incentives for both sides?

I think there is.  I would suggest as a start that law firms start reducing the emphasis on billable hours in their partnership compensation systems.  By doing so, this will encourage lawyers to focus more on the profitability of their practice, not on their own personal billable hours.  It will also incent them to lever more work down to associates and paralegals, or to outsource legal work where it makes sense.  These actions make good business sense whether an AFA is in place or not.  This will make your firm more profitable, produce high realization and reduce the overall cost of legal work.  Any resulting efficiencies from this approach which produce extra profits can be shared with your clients in the context of an AFA.

And there is much inefficiency in the way that law firms produce legal work now.  The fact is that partner compensation systems that incent partners to maximize their billable hours encourage “bloat” in the overall cost of legal work.  It also encourages firms to keep too many partners around billing at high rates.  It’s no wonder that clients are rebelling against this type of system.

Emphasis on partner hours billed has created law firms that are too top-heavy for their own good. Many firms have too many partners compared to associates and paralegals, and partners are “hoarding” work that should be levered down.  As a result, the cost of the legal services goes up due to higher chargeout rates on average.  The answer is that most firms could probably do with, say,  20% fewer partners (admittedly a number totally off the top of my head), and still handle the same work volume, but in a far more efficient way and at a lower overall cost for the client.  The tricky part is that law firms’ overall billings will go down, and partners have a vested interest to keep the compensation criteria as is to protect their own interests.   It won’t be easy, but forward-thinking firms are  addressing this issue now.  And if you don’t address this issue, these forward-thinking firms will steal your clients from you.

So the firm’s partner compensation system is the best place to start.  The smart firms that de-emphasize billable hours and focus instead on value, efficiency and reducing overall legal costs have the opportunity to take work from firms who are simply too lazy or greedy and won’t change unless they have to.

Admittedly, GC’s are incented to reduce the overall cost of legal services, so there is a conflict here with law firms’ incentive to grow the size of their practice.  But, if there is the potential to grow profits in a properly constructed AFA arrangement, then this should satisfy law firm partners who are rewarded for increasing profits for the firm and the client, not just the size of their practice.

And if the choice is to lose a good client playing big annual fees, even at a discounted rate, then partners should really get focused here.  As well,  by the time the client decides that it wants an alternative fee arrangement, it will probably have been approached by several other law  firms offering the same thing, and you’ll be yesterday’s news.

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The Search for Value – Focus on Client Profitability First

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The idea for this post was inspired by Ron Baker of Verasage Institute.  After checking out some of his writings in recent months, I stumbled across one of his key concepts in the search for value.  The definition of value is contained in this formula:

Value = Customer Profit – Price

I modified Ron’s formula slightly to illustrate the point of this post.  What this formula means is that the value you provide to your client equals the increase in customer profit resulting from your legal work and value added services minus the price you’re charging for your legal work.

With all the fuss over alternative billing lately, many have been talking about the need to cut costs and run lean operations in order to make money in the face of decreasing prices for legal work.

However, the drive to cut costs to match dropping prices for your work is in the end, I believe, a losing game.  There will always be someone who will undercut you on price, and there is no upside in this game.

Instead, you want to be the value leader, not the low-cost leader in today’s competitive legal environment. If you can achieve that, you will increase profits dramatically for both your client and your firm.

However, as the formula above indicates, the key is to focus on increasing your client’s profits first when adding value.  If you do, and you can demonstrate the impact this value has on your client’s bottom line, you will remove the pressure on price, thereby increasing your own profitability.

This is a complete rethink of the normal law firm approach to focus on their own profits first.  But if you think it through, you’ll realize that your efforts are best spent on increasing client profits first, as your profits will follow in due course, and dramatically so if you do it right.

How can you increase value?

First, talk to your clients to see what issues are keeping them up at night.  Ask them to explain their strategic vision and how you can help them achieve it.  There’s six key areas to focus on, as listed in the Law Firm Value Committee’s “51 Practical Ways For Law Firms to Add Value” list on the ACC Value Challenge website, which is an excellent place to start in the search for value.

Some of the highlights for adding value include:

- Assign professional project managers to manage large-scale engagements and teams.

- Institute a discipline such as “Lean” Six Sigma to monitor efficiencies in all areas of work.

- Create partner roles focused on driving change and enhancing the value and efficiency of client service.

- Publish your network of “known” counsel  in other jurisdictions and share it with top clients.

- Ask clients to share their own strategic visions, so the firm can properly plan, invest, staff, etc. to meet the future needs of its clients.

- Connect clients to other clients and entities in the firm’s network (at no charge).

- Engage a third-party consultant to conduct in-depth client satisfaction surveys.

- Assign a mid-level associate to work part-time at the client’s office for no charge.

- Request periodic access to meetings with the client’s business people to better understand the client’s business.

- Assign each of the firm’s summer clerks to work in the client’s law department for a week or two at no charge to the client.

- Create client service teams of lawyers and staff who serve that client and meet quarterly or monthly to discuss the client’s business, current and potential matters, changes at the client, trends in the client’s industry, etc.

- Commit to clear and transparent fee structures by showing the client what tasks are required at each step in the process of the matter, the timekeeper who will perform those tasks and the allotted time for each.

- Engage clients in the training process and invite them to make presentations and have dialogue with associates about the in-house/outside counsel relationship.

- Create a training program where associates work at the client’s facility to learn the in-house perspective.

- Develop a client dashboard that includes metrics, in addition to a 360-degree view of all matters.

- Use e-billing systems to track performance against metrics.

-  Set up an extranet for on-line training that is available to both the firm and the firm’s clients.

Admittedly, this is a big firm perspective on in-house counsel’s perception of value, as the Law Firm Value Committee is comprised mainly of large US law firm lawyers.  However, there are many good ideas here for small and midsize firms as well.

From the small and midsize law firm perspective, there is much you can do to add value.  One of the most effective ways to add value is to refer your contacts and their business to your clients to add to their top line.  Some of the most successful lawyers I know do that regularly, and their clients rarely question them on the price of their legal services.  As the value you provide to the client increases, the less important price becomes.  The only thing that matters is the net benefit of your value minus the cost of your legal services.  This value will translate into client profits at some point, and that’s what the client really wants from your relationship.

It doesn’t have to be a short-term profit add, either.  The client is as interested in a long-term, strategic partnership as you are.  In fact, the more you are around on a flat fee or portfolio billing basis, the more comfortable the client will be in calling you and getting your advice on their next big litigation file or acquisition.  You want to be available when the client calls you, before he or she calls your competitor.  So the closer you can get to the client and provide value added services like those listed above, the more likely your share of the client’s legal business will grow over time.  And that’s the ultimate goal for most law firms, as your profits will ultimately grow with your clients.

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Trends In Restructuring Law Firm Business Functions To Increase Profitability

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I’ve often wondered why so many law firms insist on keeping business functions run inhouse by lawyers, when they’d be much better off delegating or outsourcing (levering) these functions to someone who knows more about business management than they do.  This behavior can range from the Managing Partner who insists on doing the financial statements himself to the numerous lawyer-run Committees you see operating in many firms.   Many firms would get much better and faster results by having an experienced Executive Director or Administrator perform these functions for them.

Some will say that lawyers won’t listen to someone who isn’t a lawyer regarding management issues.  However, many lawyers are now realizing that they need to streamline their operations further as clients push them on the rates side and squeeze their profit margins further.  I would suggest that more lawyers need to become aware of the option to outsource these functions as well,  given the increasing demands from clients to keep costs down and provide better and faster service.  It also recognizes the need for law firms to focus on their core competency of providing legal services.

One of the main reasons to consider levering business functions is to increase profitability.  This requires that you focus on how leverage of business functions can operate in your firm to release your fee earners from administrative tasks.  Your opportunity costs can be great if you have several partners involved in management and administration functions, when they could instead be doing more productive things with their time.  Things such as getting new, highly profitable work, working on high-end files or performing high level R & D to add value to the firm’s knowledge banks and improve firm profitability.  At $400 to $1,000 per hour opportunity cost, you’d be far better off levering those admin tasks to an experienced COO or Executive Director who could do the job more effectively and efficiently.  Your “real” bottom line will grow substantially after allowing for these recovered opportunity costs .

In a recent survey I conducted with COO’s and Executive Directors of midsize and large US and Canadian law firms, I found that more firms are also looking seriously at outsourcing facilities management, document production,  systems, human resources and marketing functions.  Whole administrative departments are not only being outsourced, but are also being shared with other midsize firms.  This tactic allows midsize firms to compete for much larger files than they’d normally have  a chance at and both firms can benefit from the arrangement.  It’s just another way for firms to extend their reach to be competitive without having to merge or add extra offices, and avoid all the costs and potential heartaches that an ill-thought out merger can entail.

Orrick is an example of a firm that successfully “outsourced” all of their administrative support functions such as HR, marketing, systems, facilities management and document production to a single support center office in West Virginia.  Their global network of offices can access the admin services they need from this Global Operations Center on a 24/7/365 basis.  Through this change, Orrick has reduced administrative costs while improving the quality of these support services.

CMS Cameron McKenna in the UK is the first major law firm to outsource its entire business support function to an outside party, including IT, HR, finance, business development, communications, knowledge management, facilities management and administration services.  This is a major development/experiment and is being watched with great interest by many other firms.

Another administrative service to consider for outsourcing is the search function, such as due diligence, title search, etc.  Why firms have their paralegals do these functions is curious to me.  Paralegals should be focused on higher end legal file functions, and searches should ideally be delegated to clerical staff or outsourced to a dedicated search firm.

Another option for small and midsize firms is to outsource all of their administrative functions to companies like MCG Management Counsel Group in Toronto or Cameron Management Services Group in Calgary (no relation).  These companies can handle all of your administrative and business functions so you can focus on practising law.  I’ve heard this option works very well for some small and midsize firms.

The latest option for outsourcing administrative functions is Face2Face Solicitors in the UK, which provides franchisee solicitor firms with centralized back-office systems – including accounts, IT and regulatory compliance – and central marketing and business development, to enable lawyers to focus on the legal work.  See here for more info.

Outsourcing can done at many levels in law firms and is being experimented with in different ways by forward-thinking firms.  You can theoretically outsource any business function.  One partner I knew once jokingly suggested that he’d like to see his firm’s entire Management Committee outsourced.  Okay, that’s pushing the outsourcing concept a bit, but considering the minutiae that many Management Committees get involved with, perhaps it’s not such a farfetched idea!

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The Link Between Knowledge Management and Profitability

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Did you know there is a direct link between Knowledge Management (KM) and Profitability for law firms?  In addition, did you know that this link exists right at the top of the profit pyramid, where the impact on profitability is the greatest?  I’ve heard this link mentioned before, but haven’t heard the reasoning behind it.  Here are my thoughts on this very important concept.

So, what is behind the link between Knowledge Management and Profitability?

First, it’s generally recognized that increasing Rates can have the biggest impact on profitability.  As David Maister states in his book “Managing the Professional Service Firm“, you can increase rates through specialization, innovation and adding value. The use of properly developed KM systems can significantly increase rates in all three of these areas.

KM systems organize the information that lawyers need to develop and maintain their specialty practice areas.   KM systems also allow lawyers to innovate the way they  provide legal services to clients. Finally, KM systems add value to legal services delivered to clients.    See here for further information from KM experts such as Ann Bjork of Virtual Intelligence VQ in an article from KIM Legal magazine.

I’ve always believed that the use of KM systems has the potential to make law firms extremely profitable.  For example, the reuse of past legal work product can dramatically cut the cost of legal services and allow law firms to recover the true value of the legal knowledge they are imparting to clients.  This is done by value billing without regard to the number of hours being spent on the legal task at the time.   It’s not unethical to value bill for KM if you let the client know what you’re doing up front and give them the chance to “buy in” to a new way to dramatically reduce their overall legal spend.  At the same time, this allows law firms to expand their own profit margins by increasing effective rates dramatically.  It truly is a win-win situation for the law firm and the clients who embrace this way of doing things.

KM provides clients with exactly what they want – lower overall legal costs – while allowing law firms to increase effective rates on the legal products and services they are providing to clients.  KM allows law firms to turn legal knowledge databases into products that can reused over and over.  This allows law firms to invest for the future like other businesses, and not just build fiefdoms of partners who are only in the enterprise for their own gain.   This is where most KM initiatives usually fail, as many partners can’t get past the short-term impact to their numbers by compensation systems which are driven by short-term results at many law firms.  It takes some work to convince partners that the KM initiative will truly benefit them in the long run.  Forward-thinking Managing Partners and Compensation Committees will take into account these long-term investments of legal knowledge by partners who contribute to the development of great KM systems.  Firms can start small and simply bonus partners who provide significant contributions to the KM initiative.  See the article from KIM Legal article magazine noted above for further ideas on how to approach the KM contribution/compensation issue.

KM contributes significantly to greatly increased profitability in law firms by driving and supporting higher Rates, which is the factor that has the biggest impact on law firm profits.  I believe that once law firms truly understand this, you’ll see many law firms revisiting the KM concept.  In combination with the drive for alternative billing models which clients are clamoring for today, law firms should be able to utilize KM to help clients reduce their overall legal costs while driving their own profits higher.  In this way KM truly can be “the missing link” you’ve been searching for to dramatically increase law firm profits.

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Strategic Planning for Law Firms – Key Steps in the Process

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So what’s all the mystery about strategic planning for law firms?  Why do so many firms fail to do strategic planning, and if they do try it, why do they fail to implement?

First I’ll address the mystery part.  Most law firms are run as democracies, which allow partners to do what they want with no real accountability.  Strategic planning assumes that you are thinking about your future as a firm, not as a group of solo practitioners.  This is the key to making a strategic plan work.

Here’s some key questions to address in getting the planning process going.

Where Are We Going?

Ideally, you should follow a standard strategic planning process, which involves creating a mission statement and long-term vision for the firm.  The strategic planning process will address the next 3 to 5 years, and should be revisited every 3 to 5 years as the environment changes.

Who Are We?

A core values statement is also essential, to guide all partners and staff on the firm’s expectations of its people.  This will decide who’s in the boat, and who isn’t.  The core values statement is normally created separately from the mission statement, but must support it.

What’s Stopping Us From Achieving Our Vision?

First you need to identify the key issues facing your firm at the moment.  This gives you a place to start turning issues into goals and strategies.  Every issue is a potential hurdle which is preventing you from achieving your firm’s goals.  The firm’s  key issues should be summarized and prioritized.  The top 5 issues should be discussed and ideas exchanged on how the issues are stopping the firm from achieving its mission statement and vision.

What Are The Steps Along the Way To Achieving Our Vision?

Once the mission statement and vision are determined, usually during a strategic planning session with all partners, then you can start eliciting goals from the mission statement. The firm’s goals are normally contained within the mission statement.  Focus on the top 5 goals.

Quantify Objectives

With the top 5 firm goals decided on, you can then quantify objectives which must be met in order to achieve the goals.

How Do We Get There?

Conduct a brainstorming process to consider various strategies to help achieve the goals.  Prioritize the strategies needed to achieve the goals.

Who Will Do What And By When?

This is the action planning stage.  Here we identify who will carry out the strategies and assign deadlines to complete the action plans.  This provides accountability and helps with follow-through.

How Do We Ensure It All Gets Done?

This is where most firms fall down and don’t implement their plans.  You need a management structure with accountability to make it happen.  The Managing Partner will be in charge of executing the firm plan and will ensure every partner does their part in implementing the plan.  The Managing Partner must also be able to impact partner compensation to make partners accountable for their role in the process.

The Top 5 Things Law Firms Need To Do Now To Increase Profitability

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Here’s some issues that are common amongst small and midsized law firms that should be addressed now to increase profitability.

1. Management

Too many firms try to run as democracies where partners have full say on which clients they work for and the type of work they do.  They’re not accountable for their actions and effectively act as solo practitioners.  This is a sure recipe for mediocrity and substandard profitability. You need to centralize management with a Managing Partner assigned the authority to screen all significant new clients for potential profitability, say no to high credit risks, and impact partner compensation to ensure all partners are accountable for their actions and performance.  The Managing Partner will also direct strategic planning and execute the Firm Plan.

2. People

You need the right people. Many firms have ill-defined partnership entry criteria and even less understanding of what it takes to remain a partner.  As a result, you end up with mediocre people and risk losing your best people to your competitors.  You need to have high-performing people to move the firm forward and achieve your firm goals and profitability targets.  Ensure your top performers are paid what they’re worth. Define partnership entry and retention criteria and enforce these criteria regularly.

3. Clients

You need to be constantly pruning your client base and upgrading your clients.  Studies show that  80% of your profits come from 20% of your clients.  You need to figure out who these high profit clients are and how to get more work from these clients. At the same time, you need to review and replace low profit clients with better opportunities.  Get a list of your top 50 clients and start reviewing them for profitability and ask them if they’re satisfied.  Do some client satisfaction interviews and you’ll generate more work from your most profitable clients simply by going through the interview process.

4. Vision

You need the “right” vision and a process for initiating strategic planning on an ongoing basis.  Start with a strategic planning process involving all partners and facilitate the creation of a new Vision and Firm Plan.  This will help direct your efforts in the most effective way and will help  increase profitability dramatically if you get all  partners to “buy in” to the new Vision.

5. Systems

You need to reward partners for cash in, not billings.  Many firms focus on volume without looking at the quality of the work being brought in and worked on.  You need to examine realization and profitability of all your clients.  To do that, you need a system to quickly determine profitability of clients and practice areas and services provided.  You also need to determine your cost per billable hour and create strategies to reduce costs and increase your profit margins.

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Focus on Prevention, Not Collections

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Many firms spend a lot of time trying to collect bad debts instead of preventing them in the first place.  You can change that with a good file opening system, with your Managing Partner approving all new clients and files over a certain size.

Why do this?  Because many law firms’ compensation systems reward partners for volume of billings or hours generated, not quality of billings or hours.  Even firms that reward partners for cash received instead of billings still have to deal with long delays in receiving cash for work billed.  The best way to avoid this is to deal with the problem right at file opening.

You need to give the Managing Partner the authority to say no when a new client presents a high credit risk.  The Managing Partner is not infallible so you also need to build a simple methodology up front to allow partners to take on new clients on  a short leash. This is especially important if they’ve taken on too many flyers in the past and the firm has worn the results.

A credit limit system is the other half of the prevention solution. Combined with a good file opening approval system, the credit limit system works just like Sears or Macy’s in approving your new credit card.  You get a credit check done for all new clients and assess the clients’ credit history.  You then set a total credit limit for the new client which includes total WIP and A/R.  The client is informed of the credit limit system in the initial engagement letter.  If the value of total WIP and A/R for the client goes over the set limit, lawyers cannot record any more time for the client and the client is told that work has stopped on their file until they have paid their outstanding bills.

Simple, right?  Okay, in practice it takes a bit more time to get all partners on board, but once they see the results, they toe the line gladly.  Especially when the reward is more money in their pocket.  If you can reduce the firm’s total investment in WIP and A/R from five months to four months using this system, you’ve just reduced each partner’s share of required capital by one month’s billings – a significant sum.  And that money stays in partners’ pockets as long as they keep the firm’s total investment in WIP and A/R down at four months.  So partners are incentivized to cooperate with the system and do what they can to help prevent future bad debts.  This naturally leads to a significant improvement in the quality of the firm’s clients over time. And that’s the real reward, since that leads to many more benefits for the firm and its partners in the long run.